Whether Negative Control Amounts to Control under SEBI Takeover Code 2011

As per the Takeover Regulations 2011 the term ‘control’ in regulation 2(1)(e) has been defined as the “right to appoint majority of directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner”.

In practical scenario this term is not that easy to interpretate. Let us take an example of Share Purchase Agreement, whereby, the investors agrees to invest in the Company and in order to secure the proper use of its investment, wants some restrictive clauses in the Share Purchase Agreement, that is to say, it is not demanding or controlling the policy making or say decision making of the Company. But investor wants some kind of negative control over the Company, which, in turn will secure and protect its investment. No investor will invest in the Company until and unless the investor would be convinced with the fact that its investment is in safe heaven or it has some kind of rights to look after its money.

Now, let us discuss what is Negative Control:

Negative Control that is often exercised by veto rights, veto rights that are common in most investor agreements, agreements that in SEBI’s eyes are often judged to have crossed takeover thresholds and triggered an open offer. But last year, the Securities Appellate Tribunal (SAT) put a twist in the negative control tale.

It is quite usual to enter into share purchase agreement for investing into any Company. Share Purchase Agreement is essentially a contract between shareholders in a company, the purpose of which is to confer rights to and impose obligations on the shareholders over and above those provided by the Company Law.

Though, there is no statutory requirement for entering into Share Purchase Agreement, while investing into the Company. It is mere a contract which provides for some extra rights over and above the rights which are conferred by the Company Law. Share Purchase Agreement provides contractual remedy to an aggrieved shareholder in the event of any breach of any covenant or representation by the other shareholder. This contractual remedy is available to a shareholder in addition to the statutory rights provided under the Companies Act, if the Articles of Association have been amended to incorporate the relevant provisions of the Share Purchase Agreement.

These extra right which are provided to the investor by virtue of an agreement entered into between Company and investors, in general includes, Right of First Refusal, Prior consent for any type of corporate actions or restructuring, Call option, Put Option, right to appoint Directors, change in objects etc.

Whether Negative Control amounts to Control:

Here, the question arises, by virtue of such negative rights also, some kind of control is transferred to the investor, though negatively, but the investor may affect the decisions of the Company. In view of this situation, it was quite difficult to interpretate, whether acquisition of negative control would amount to acquisition of control as per SEBI Takeover Code 2011 and triggers open offer?

Last year in a ruling, the Securities Appellate Tribunal held that-Power by which an acquirer can only prevent a company from doing what the latter wants to do is by itself not control. In that event, the acquirer is only reacting rather than taking the initiative. It is a positive power and not a negative power. This was the ruling that reverses SEBIs longstanding position that any rights in the hands of an acquirer would constitute control over a target company.

This was a welcome decision for all private equity investors. As substantial investors, they would obviously be looking at protecting their interest in the company and would seek certain customary rights. However, the decision does not exempt all kind of Veto Right from the purview of Control; we need to analyze each case separately.

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